Board of Directors’ Reliance on Legal Advisers

The
question of whether, and to what extent, the board of directors of a company
can rely upon the advise of the legal advisers of the company came up for
consideration before a division bench of the Rajasthan High Court in Rajasthan Urban Co-operative Bank
Ltd. v. Ajay Kumar Katewa (hat-tip: LiveLaw,
once again). In this case, certain employees of a co-operative bank were
compulsorily retired, which action was challenged by those employees before the
High Court.

The
employees were retired in terms of rules 14 and 15 of the Urban Cooperative
Bank Employees Service Rules, 2006 (the “Rules”), which provided that the board
of directors of the bank had to be satisfied as to the existence of specific
grounds for such retirement and also to give reasons to show that the
retirement was in the bank’s interest. The High Court negatived the bank’s plea
that the board had relied on legal advice while deciding that the grounds under
the Rules were satisfied. It noted:

10. In pursuance to the directions of the
Single Bench, record pertaining to the retirement/compulsory retirement was
produced by the counsel for the appellant bank wherein it was evident that the
impugned orders had been passed by the Board of Directors on the advise of the
Legal Advisers and the Banking Experts. In terms of Rule 15, it was incumbent
upon the Board of Directors to have independently applied their mind and taken
decision based on specific grounds. The specific grounds which have been spelt
out in Rule 15 include doubtful integrity or incompetence to discharge official
duties or inefficiency in due performance of official duties which would have
the effect of the employees losing their utility.

11. It was, therefore, necessary for the
Board of Directors to have independently considered the entire service record
of the employees so as to form opinion with regard to their utility to the
Bank. The requirement of recording specific grounds to arrive at the decision
in the rules is intended to ensure that the Board of Directors does not act
arbitrarily while compulsorily retiring the employees. There does not seem to
be any independent and due application of mind on the part of the Board of
Directors while arriving at the decision which has the effect of bringing the
services of the employees to a premature end. The function which had been
entrusted upon the Board of Directors by the rule could not have been
outsourced to the legal advisers.

For
these reasons, the decisions made by the board of director’s of the bank were
set aside.

At
the outset, it is to be noted that this is not a case under company law, but under
employment law and service conditions. To that extent, it is not a typical
directors’ fiduciary duty claim that would be brought by the company or a
shareholder (by way of a derivative action). However, the ruling may have some
broader implications in the discussion of directors’ duties.

The
most significant implication is that the directors will have to apply their
minds to decision-making powers that have been granted under statute or
subsidiary legislation. They cannot simply rely on experts such as legal
advisers, but can only be guided by their advice. This becomes relevant in the
context of the enhanced duties imposed under company law as well by the
Companies Act, 2013. However, this could also create some practical difficulties,
as boards of directors – especially in large companies – may not be in a
position to make operational decisions such as retaining or terminating
employees. Of course, some of these functions can be delegated to management
committees who may in turn report to the entire board.

Alternatively,
it would be possible to consider controlled delegation similar to that provided
under the Companies Act in Singapore where section 157C allows directors to
rely on expert advice so long as the directors act in good faith, they make
proper inquiry as circumstances require, and where they have no knowledge that
such reliance in unwarranted. This provides a balance whereby directors may
place reliance on external sources, but they cannot abdicate their duties
entirely as they have to satisfy the conditions stipulated above. While in
India the Companies Act, 2013 does not carry express stipulation on matters
relating to delegation and reliance, these aspects may be considered by the
courts and tribunals while interpreting the duties of directors set forth in
section 166 of the Act.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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